WESTPAC: The best of the ‘Euro boom’ is behind us

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  • The Euro area economy has been a standout performer globally over the past couple of years.
  • Westpac Bank thinks the best of the recovery is now behind us, forecasting that growth will slow.
  • Expects household consumption to moderate after demand brought forward by strong consumer credit growth.

The European economic recovery over recent years, affectionately referred to as the “Euro boom” by some, has probably already seen its peak.

That’s the view of Westpac Bank which is forecasting economic growth across the Euro area to slow in the coming years despite continued strength in labour market conditions.

“With the benefit of hindsight, we believe that 2017 will be seen as this cycle’s peak year for Euro Area growth,” says Elliot Clarke, economist at Westpac. “Against the 2.5% year-average outcome for 2017, we foresee growth of 2.1% in 2018 then 1.6% in 2019.”

Somewhat counter-intuitively, Clarke says this slowdown will occur despite the likelihood of continued strength in labour market conditions, household incomes and improved consumer sentiment, something that would normally act as a tailwind for household consumption.

“The growth trend has been flattered over the past three years by a wave of nonrecurring pent-up demand that has finally been released after being held back for many years,” he says.

“Importantly, this spending has partly been funded by the much freer availability of consumer credit in addition to household income.

“This has allowed consumption growth across the continent to run well ahead of the pace that income growth would have allowed.”

As seen in the chart below from Westpac, annual consumer credit growth soared in recent years as economic and labour market conditions improved.

Source: Westpac Bank

“To put the support of credit into perspective, at 6.2% the current annual pace of consumer credit growth is just a touch below the mid-2016 peak of 6.5%, a high back to mid-2006, prior to the GFC,” Clarke says.

“It is also a multiple of current mortgage credit growth, 2.7%, and, more importantly, compensation per employee at 1.8%.”

So credit growth has been outpacing income growth of late, an outcome that Clarke doesn’t expect will last even with stronger labour market conditions.

Nor does he expect much of a tailwind for spending to come from households continuing to draw down their savings.

“This reduction of savings may be offset by wealth gains on housing and equities, but unless an asset is sold, household cash balances will remain depleted,” he says.

As such, Clarke expects a consumer-led moderation in economic growth to arrive over the next couple of years.

However, he doesn’t think it will be enough to derail monetary policy normalisation from the European Central Bank (ECB) unless the deceleration is even more pronounced.

“Both the ECB’s and our expectation remain constructive, with growth to remain above potential. That would be enough to warrant a few gradual rate hikes,” he says.

“The risk, however, is that the consumers’ appetite to spend recedes more dramatically and/or income growth disappoints, forcing the issue.

“Either outcome would delay the ECB from rate hikes indefinitely.”